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Aggressive Fed cuts rates by 50 basis points

Stocks surged after the Federal Reserve moved aggressively to head off the risk of a sharp slowdown in the US economy on Tuesday, cutting interest rates by 50 basis points to 4.75%.

The Fed said the rate cut was intended to â€œhelp forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial marketsâ€?. It also cut the discount rate at which it lends directly to banks by 50bp. The Fed said core inflation had â€œimproved modestly this yearâ€? - a shift since the last meeting. But the US central bank added that â€œsome inflation risks remainâ€? and the committee pledged to â€œcontinue to monitor inflation developments carefullyâ€?.

The S&P 500, which was up about 0.5% before the Fed decision, closed up 2.9% at 1,519.78.

Financial Times, Lex, Comment:

Ben Bernankeâ€™s half-point cut in both the Fed funds rate and the discount rate will certainly draw criticism from some quarters that the Fed has panicked in the face of weak but not disastrous economic data. It also risks fuelling the belief that there is a â€œBernanke putâ€? - and the Fed will always ride in to save the markets.

However, the real test starts now. If the Fed is willing to shock the market with an unexpected gift, it must also be willing to spring negative surprises when the risks look more balanced. The Fedâ€™s wording did not promise more cuts. If its shock treatment works on the financial system and the economy proves stronger than expected, the central bank must be willing to take back its gift rapidly. If not, Bernankeâ€™s detractors will be proved right.